ESG and benchmark indexing: the road to proliferation and obliteration

Algo-Chain's Allan Lane looks at how ESG has come of age as an investment idea in 2019…

It has been close to 30 years since the fall of the Berlin Wall in late 1989, and at the time it was quite clear to many that life would never be the same again. Little did they know, with the internet still at an embryonic stage, this hand maiden to free expression would unleash an avalanche of discontent and invective that would change personal behaviour beyond all recognition.

Perhaps not surprisingly as the volume of content grew exponentially, so did the need to bring order to the ensuing chaos. And so it is with environmental, social and governance issues, the three central factors when measuring the sustainability and ethical impact of an investment in a company or business, often referred to as ESG. 

If there was one investment idea that came of age in 2019, that was proliferation of all things ESG. Take it as read that once the Reading music festival had featured its last band, it has become standard fare to compare the past and present aerial photos of the site. Bless them, fitting with the times, the audience members now deem it cool to actually consider taking their tents back home with them. 

If ever there was a sign that the financial services industry needed to take the ESG movement more seriously, then this was it. No one, however, has told the ETF issuers and the index providers, as they continue to pump out new product. Index provider MSCI has taken pole position with its extensive ESG Rating system. To this we can add the hundreds of new ESG centric benchmark indices from the likes of S&P, FTSE, and indeed MSCI themselves. Where there’s a new benchmark index, don’t be surprised to find that there is a new ETF lurking in the bushes somewhere.

Very soon one realises one has seen this all before. Back to 1989 and the explosive growth that the dance music genre witnessed and before you knew it the music industry was awash with so many new dance genres that ranged from Acid House to Dub Step, with many excursions along the way. Let’s not deny it, it was technology that did it for the music industry and over the 30 years since then the industry would re-discover revenue generating activities, obviously with live concerts being the first one that comes to mind.

I do feel I am getting ahead of myself here, so let me backtrack and fill in the gaps. The explosion of interest in ESG is such that it already presents a glimpse of what the future might look like and with that vison comes a lot of tough questions. At the rate we are going, it feels that before too long every stock in every mainstream equity index will be eligible for the ESG attribute. If so, this somewhat negates the need for MSCI’s rating system, or S&P ESG specific indices. Likewise, what does it mean to only partly monitor your portfolio’s ESG score? Realising that Microsoft is often in the top holdings of many ESG benchmarks, makes one ask what other stocks in your other index trackers, in which you are invested, are themselves ESG friendly? 

The inherent complexity of the classification challenge is the one topic that critics often bring to the fore. I’m sure in many cases agreement will be reached on what constitutes a good rating system, and let’s not forget that in an age of Big Data, proliferation is nothing more than an extra gigabyte of storage space. As with the music industry though, I do anticipate a back to basics approach in the years ahead. What’s more I wouldn’t be surprised if the middleman, which in this case is the index provider, will in many instances be eliminated.  

Author Profile